This blog is about thinking about the world in a different and profitable way.

08/23/2012

Warren Buffett’s track record, the Power of Compounding Return and the Story of the Ugly Ducklings

Warren Buffett’s real track record

We all know Warren Buffett’s as one of the richest men in
the world and the most successful investor of all time. But few really know
what is Warren Buffett’s actual track record. To be the richest man in the
world, surely he doubles or triples his money every year. It is a logical
assumption. You will be pleasantly surprised. Over the years since 1965, Warren
has “only” achieved an average return of 20.3% annually. (Depending on how
recent you compute his average returns but that is his records.) If you compare
that to some star hedge fund managers and even some retail investors, 20%
annual return is nothing worth shouting about.

How can this be? We are talking about the richest man in the
world (his best friend Bill Gates beat him occasionally but the verdict is
still out)! The magic is the power of Compounding Returns and Consistency. Take
a calculator and key in “$1000”, multiply it by 1.2. And then multiply it by
1.2 and do it 47 times. You get $5,266,457.26.
If that is too much work, key this in your Excel spreadsheet “=1000*1.2^47). That
is 5266 times over a period of 47 years with a mere $1000. This is a simple
illustration excluding dividends and other profits. Warren succeeds
phenomenally because he delivers consistent results unlike the one-hit wonders
you read in business and investment magazines. These “star” hedge fund managers
make a stunning profit in one year by making a clever bet, win all the industry
awards, brag about their one-time success in all the marketing brochure and
fail to deliver the next year. Oh, I forgot one more thing. You need to live
long too.

What are
the lessons we can learn from Warren Buffett?

As retail
investors, we ought to be brutally honest with ourselves. I often hear amazing
success stories from retail investors. They make a stunning return with one
investment and without doing the mathematics, claim they are super investors
who can return 50% a year. Of course, they sweep their other losses under the
carpet. The key point is consistency. Investment is a long distance run for
people who have the right vision, patience, temperament and intelligence. It is
fundamentally different from gambling or get rich quick bets. It is not enough
to win a race a year, you must consistently win every race every year.

As
professional managers, we should think longer term. Warren’s teacher Benjamin
Graham has introduced us the power of Value Investment. Conceptually, it is to
buy assets below its intrinsic value (“fair value”) whenever the markets
misprice the asset or are slow to pay attention to it. My investment teacher,
Eric Kong, who is a long-time partner and mentor, (rated top-ten Asia fund manager
by Mercer when he was running a fund) explained this concept using a simple
analogy. It is like picking an ugly duckling in the pond when other ignore it
and you have the foresight knowing that it will grow up to be a swan. I told
him that this requires incredible intelligence and maybe a lot of luck. He
smiled and told me something even more stunning. The problem with most
investors is their obsession with chasing the most beautiful birds in the pond.
Competition for an asset means unrealistic pricing like the recent Facebook
with a price/earning ratio of 75 times. It takes 75 years before you can recoup
your investment in Facebook if its profitability stays stagnant. The real
secret in value investment is not to chase the hottest stocks or follow the
“star” managers but to invest in a portfolio of companies that have a good
sustainable business models and yet they are priced fairly because the rest of
the investors take no notice of them. To stretch the analogy further, by
picking a group of young, promising ducklings that are presently ignored by the
rest, you will have a statistically higher chance of super returns than
fighting with the rest who misprice their prized birds.

We learnt
these core lessons in IOC. We believe in value investment. We walk the Warren
Buffett Way but we adapted his Way into the Asian investment arena. We hunt our
deals diligently and carefully like Warren Buffett but we are also cognizant of
the inherent complexities in Asia. We invest in a successful global franchise
(one of Warren’s most successful investment is in Macdonald Restaurant) and
combine that with investments in pre-IPO technology companies. Along the way,
we will evolve and get even better at what we do but our core investment
philosophies will always remain the same. “Transform.
Create. Value.” – will be our key principles.

Comments

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Hi Mr Harold Fock,

Thanks for your article. Recently, I went to an IOC seminar regarding Heulab investment. The profit generated by the convertible bonds seems great.The IOC agent claimed the bonds can generate 6% profit every 45days for the minimum amount invested.
How do profits come from the convertible bonds?

I wish to ask your opinion on this investment before I invest in this. Thanks.